Judging recovery time from the Great Recession

Some economists say the current crisis fits a typical pattern

By

RussBritt

LOS ANGELES (MarketWatch) — Getting a handle on how long it’ll take to recover from the Great Recession is more art than science, but a few economists think there are lessons from the past that might prove useful for those seeking a light at the end of the tunnel.

Academics from California to Massachusetts agree this last downturn is unlike any of the nation’s 10 previous recessions, dating back to the Great Depression. The collapse of the nation’s financial system is the main culprit, though there is plenty of blame to spread around: the housing and credit bubbles, to name two other offenders.

What is unclear, however, is whether more could have been done by President Barack Obama to get the economy up to speed faster. That, of course, is the central question in this year’s election, and voters’ answer to that question will go a long way toward determining if Obama gets a second stint in the Oval Office or if Republican challenger Mitt Romney unseats him.

While some economists, not all them conservatives, say more could have been done, others point out past history indicates that given the size and scope of the downturn — virtually a depression in some views — the economy’s recovery is relatively on schedule.

“We’re way below how a normal recession [would behave] . But we’re about even, maybe a little better, than what a financial recession looks like,” said Alan Taylor, an economics professor at the University of Virginia.

Fact-checking recessions

Taylor recently released an article “Fact-checking Financial Recessions,” an update of a 2011 study conducted for the National Bureau of Economic Research. He and two colleagues examined the recovery patterns of 223 recessions in 14 advanced countries over the last 142 years. The study shows that downturns precipitated by a financial system collapse last longer and are much deeper than more “normal” recessions. Read about Taylor’s paper here.

Taylor’s study, conducted with Federal Reserve researcher Oscar Jorda and Moritz Schularick, economics professor at the University of Berlin, is similar to that of a 2007 examination that also was recently updated by Harvard University economics professors Carmen Reinhart and Kenneth Rogoff. The Harvard duo later published their findings in the 2009 book “This Time is Different: Eight Centuries of Financial Folly.”

“Rather than the V-shaped recovery that is typical of most post-war recessions, [U.S.] growth has been slow and halting,” Reinhart and Rogoff wrote in their most recent update of their research, an essay released last week. “Based on our research, this disappointing performance should not be surprising.” See the report here.

But some conservative economists take issue with the studies. They also disagree with the premise, articulated by former President Bill Clinton at the Democratic convention in September, that no president could have cured all the nation’s economic woes within four years.

“[Obama] focused exclusively on short-term band-aids,” said Lee Ohanian, a fellow at the conservative Hoover Institution at Stanford University in Palo Alto, Calif., and current economics professor at UCLA, of the various stimulus efforts by the president. “These short-term band-aids didn’t do anything to help.”

Faster bouncebacks

Michael Bordo, another Hoover fellow who teaches economics at Rutgers University, conducted his own study with Cleveland Fed Vice President Joseph Haubrich. Bordo contends there have been several recessions with a financial crisis element since World War II, and those have all bounced back faster than the current downturn. See the study here.

Bordo, along with conservative economists Kevin Hassett and Glenn Hubbard, have been feuding in op-ed pages with Reinhart and Rogoff over the pace of the recovery. Advisors to the Romney campaign, Hassett is a fellow at the conservative American Enterprise Institute and Hubbard, a visiting scholar at AEI, was chairman of the Council of Economic Advisers under George W. Bush. Bordo isn’t affiliated with the Romney campaign but says he supports the Republican.

The three insist that correlating the U.S. economy with other nations is a mistake.

“They’re pulling data across a number of countries, all of which have different institutional environments, different policies,” Bordo said of the Harvard study as well as Taylor’s. “There’s a lot of information that’s going in there.”

Bordo, though, says this recession is different since it was compounded by the housing bubble, an element that has never played a significant nationwide role in previous downturns and could be the nagging factor in this crisis.

Asked if Clinton was right about when he insisted this downturn couldn’t have been shortened, Bordo said: “I don’t know. I really don’t know.”

Taylor and the Harvard duo say they have no political motivation when it comes to examining recession patterns, and aren’t questioning government policy. Taylor’s paper first was completed a year ago and Reinhart and Rogoff started looking at the issue in late 2007, 11 months before Obama was elected.

Key metric

Both studies use real per-capita GDP as their barometer for determining when a downturn has run its course. According to their data, the end of a downturn is complete when that gauge, which measures individual productivity, has returned to its pre-recession peak and is starting to grow again.

Taylor says that in most “normal” recessions, real per-capita GDP dips for one year, returns to its pre-recession peak within a year or two, and then starts surging past the old peak. Bureau of Economic Analysis data show this was true in all recessions dating back to World War II.

For the Great Depression, though, it took until 1939 for that gauge to get back to levels reached in 1929, prior to the stock market crash, the BEA says. Stocks generally recover at about the same pace as individual productivity, but that wasn’t true for the Depression. Back then, it took the Dow Jones Industrial Average
DJIA, +0.14%
25 years to get back to its 1929 levels.

“There’s a reason it was called the Great Depression,” Taylor said with a chuckle. “We can have a lot of depressions but they’re not all great. It was the great one for a reason.”

With the current downturn, real per-capita GDP hit a peak in December 2007, Taylor says. BEA figures show that the metric reached $44,005 in the fourth quarter of that year and haven’t revisited that level since.

BEA data show the low point was the second quarter of 2009, when the GDP metric hit $41,389. It has been slowly climbing, for the most part, since then and now stands at $43,152, roughly 98% of where it was at the pre-recession peak. The Dow, meanwhile, stands at about 94% of its pre-recession peak.

Taylor says when it comes to real per-capita GDP, the current slow recovery fits the pattern of other similar, bank-fueled recessions in other mature economies, as well as the pre-Depression bank “panics” in the U.S.

The credit factor

Of 223 recessions Taylor looked at, 50 were initiated by a financial crisis. One key difference between Taylor’s study and that of the Harvard researchers is he examines how an excessive amount of credit issued in the years leading up to a banking downturn will factor into the equation. In the current malaise, he estimates that a medium-to-high level of excess credit circulated throughout the U.S.

Taylor says bank loans alone put the U.S. into the “medium” excess credit level, but there has been what he calls a substantial amount of what he calls “shadow credit” — student and auto loans, credit cards and securitized mortgages. He says there probably was enough of that to catapult the U.S. well into the “high” excess category.

His data show that even after five years, individual productivity still is slightly below the pre-downturn peak in the average bank-fueled recession. BEA data show the current downturn was steeper during the first year when compared with what Taylor says is the average bank-fueled recession, but recovered faster and is slightly ahead of schedule.

“I think it’s pretty much on par, maybe a little better, if you take into account the shadow system. When you put in the extra bit of credit that was generated, the [GDP] path could have actually been lower,” he said.

In another update to the study released earlier this week, Taylor points out that the U.S. is doing much better than the U.K. While the U.S. is getting close to pre-recession GDP levels, the U.K. appears headed for another downturn in productivity, he notes.

No ax to grind

There are some economists who say they don’t have a political ax to grind and yet remain critical of Obama’s handling of the crisis, or at least don’t think the downturn needed to last as long as it has. But views differ on the best remedy.

Enrique Mendoza, economics professor at the University of Maryland, says Obama diagnosed the problem incorrectly, using Keynesian tactics of government largesse to try and boost demand. Quantitative easing should have been introduced simultaneously with the bank bailout, and a more aggressive addressing of the housing crisis should have been the order of the day, he says.

“The approach of attacking the crisis mainly with massive fiscal and monetary easing completely missed the point that the financial crisis was the culprit, not the Keynesian fairy that made private demand disappear,” he said.

Barry Eichengreen, economics professor at University of California, Berkeley, says even if this is a typical bank-fueled recession, the nation is right to demand quicker solutions because the U.S. is the world’s biggest economy and it has its own currency. But he thinks more stimulus might have been the answer.

“When debt is free and when interest rates are zero and the private sector is deleveraging, that is the right thing to do,” he said.

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